Will inflation return? And for whom will it be good and for whom will it be bad? These days, many operators are once again asking themselves about the possibility that after many years of zero or subzero rates and stable or falling prices, the merry-go-round of inflation can start again. The fuse was lit by the president of the Federal Reserve, Jerome Powell, who announced the new policy of the American central bank: to let inflation rise above the limit considered physiological, or 2 percent, in the coming months or years. without intervening: And the expectations of the operators, measured by precise indices (the 5-Year5-Year Forward Inflation Expectation Rate, which measures the 5-year expectations), have already grown both in the USA and in Europe. “It seems that everyone is waiting for inflation to return to solve, if not all, many problems,” he explains in this interview Franco Bruni, professor emeritus at the Bocconi University of Milan and vice president of Ispi. “But inflation is an ugly beast, especially when – as past experiences show – it loses control, which in certain circumstances can easily happen. Yet there are many powerful forces in the world that push for this solution, but let’s face it clearly: most ordinary citizens would only have to lose from accentuated inflation, above 2-3 percent, which in fact is the limit that is the US and European central banks are given ”.
Professor Bruni, what would be the powerful forces pushing for the return of inflation?
“All large debtors, whose debt in real terms would automatically decrease if prices increased. To give a simple example, if I make a debt of 100 and after a year the purchasing power of 100 euros has devalued by 5%, because the prices are 5% higher, I am happy as a debtor. Of course, creditors do not. The big debtors are all governments, which among other things have now also had to further increase their public debt to meet Covid; and many banking and financial intermediaries. In short, as you see, all the great protagonists of world economic power ”.
If governments and financiers around the world are so interested in inflation, why have prices remained essentially stuck in recent years? Yet central banks, including the Federal Reserve and the ECB, have tried in every way in recent years, lowering rates and injecting liquidity into the market to help a generally stagnant economy and raise inflation.
“Having been years of difficult growth, prices have not risen as expected, as central banks wished. The association between growth and inflation is no longer what it used to be. This is another reason why all the moves of the central banks have proved useless and have actually created other problems ”.
What has changed?
“There are at least two factors that have changed the scenario. Globalization is the first. I explain it to you very simply: it is difficult to raise prices in one part of the world if someone else makes them fall. Inflation has become a worldwide phenomenon as everyone imports and exports around the world. If there are specific causes of inflation in a country or area, global interconnectedness quickly smooths them out. Let me give you an example: if the Euro area managed to raise prices, their descent in Eastern Europe would be enough to smooth out inflation ”.
What about the other factors?
“The second is the competitive environment, favored by technology, especially information technology. Just think about how easy it is to compare prices on the Internet. Today everyone in the world feels the competitive pressure as never before, from the small shop in Milan to the semiconductor manufacturer in China to the professional in Bari, everyone keeps prices under control, everyone tries to make lower prices. There are new competitive strategies around, even on prices and even when demand is pulling well ”.
In short, is there nothing to do? Despite the Fed’s new intention, won’t inflation return?
“I don’t think it will be easy to raise it if things stay that way, unless the scenario changes.”
And how?
“Covid could accelerate some trends already underway towards the return of the international situation to a pre-globalization level. If production stops, if the barriers for the movement of capital and people return, if the exchange of goods is reduced, if technological progress is interrupted, then there could be a return to the past. In a de-globalized world, inflation could rise again ”.
At present this still seems an unlikely scenario. But instead one thing is not clear: the lowering of rates and the injection of liquidity made in recent years have not been able to raise prices, but where have they gone?
“To reinforce another type of inflation, which already exists, that of stocks on the stock exchange, of some real estate prices, of the so-called“ asset prices ”. Which is not good at all. How do you explain that the stock exchanges go up just when the signals from the economy are as negative as in recent months? In the United States there are financial institutions, and not just banks, which raise at virtually zero rates and finance the financeable, buying securities of companies of all kinds, even “boiled” or in shaky developing countries. I would like to make people understand something that is often overlooked: when rates are too low, since you cannot buy safe securities at a good yield, you tend to move to high-risk securities for no real reason other than to make liquidity available. But now the central banks are also beginning to understand that the level of prices of equities and other assets must also be kept under observation in order to decide on monetary policy ”.
But is there a “good” price growth, which is needed for development?
“Yup. As the central banks recount in their sacred texts, the economy works well when the prices of goods that are “in demand” rise compared to those of low-demand goods. This mechanism works best when prices go up a bit: this is why 2 percent inflation is considered positive by central banks. But if it greatly exceeds this level, the negative effects are predominant ”.
What would they be?
“As I said before, all those who are in debt benefit from high inflation because their debt goes down without them doing anything. Inflation is an implicit tax on savings. We also think of all those who have income from employment or retirement, including young people, who would be disadvantaged. In general, those who have the power to move and anticipate the rise in prices benefit from high inflation: traders, producers with strong market power, property developers, speculators who buy at low prices to resell at higher prices “.
You mentioned the young people. Many of these, born from the mid-80s onwards, do not seem to have any fear of inflation, perhaps they do not even understand well what it is and what dangers it contains. Is that so?
“That’s it. When at the University we talk about the Italian economic history of the 70s and 80s, with double-digit inflation, students have a hard time understanding all the implications. They listen with curiosity, but how they would listen to an interesting tale that doesn’t concern them; we, who were there, are, on the other hand, rightly afraid of it ”.
This underestimation of the dangers of runaway inflation also emerges when, on a political level, we talk about the exit from the Euro as a panacea for our ills. But wouldn’t the exit from the Euro imply, before anything else, a race of inflation?
“Yes sure. And the first to be hit by the inflation-devaluation spiral would be pensioners and all fixed incomes. But also, it should be remembered, all savings, especially of the simplest people who do not have the tools to protect the accumulated money, as happened in the seventies and eighties “.
So is it better today than then?
“Absolutely yes. The current situation is much better than that of the 1970s. It was an ugly world: domestic products were losing competitiveness abroad, they cost more because the exchange rate was devalued: high inflation raised interest rates a lot, distorted the exchange rate and from time to time it was necessary to devaluate. And to avoid the flight from the devaluing lira there were restrictions on the free movement of capital, it was a problem to get the currency even for a short vacation abroad. Obstacles were also created for the international trade in goods and services, and at times it led to state intervention to freeze prices. Large companies with activities also abroad were privileged and were financed cheaper (we talked about “Fiat lira” for example) while SMEs were unable to compete until there was a new devaluation. As for wages, there was an absurd inflation compensation system, the “single point of contingency” that defended only the lowest wages while sacrificing the middle classes. And all those who kept money in the bank were disadvantaged, especially small savers ”.
Professor Bruni, but could this “bad” scenario repeat itself in the future? Or will central banks be able to control any recovery in inflation within limits considered physiological?
“There is no guarantee that inflation will not rise too much tomorrow, the danger is always lurking because there are too many variables and they can always get out of hand. The recovery in inflation could also be helped by the combination of excess liquidity created by expansionary monetary policies with production and trade blocks due to the pandemic. Furthermore, there is another factor: the inflation spark could be triggered by the expectations of traders, which are more important today than the rate of inflation itself. These expectations could trigger a mounting fear, with interest rates rising even before prices, stopping investments and falling stock markets ”.
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